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There are More Satyams Out There

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January 09, 2009 – Comments (0) | RELATED TICKERS: EEM , ADRE , BKF

There are More Satyams Out There

Author: Rakesh Saxena

No doubt, authorities in India will pursue fraud and misappropriation charges against Satyam Computer (SAY) Chairman Ramalinga Raju. However, US investors need to be more concerned about the real possibility that disclosure documents filed by a fair proportion of emerging market listings, traded in the US or on domestic exchanges, are providing hopelessly inadequate (and misleading) trading guidance.

Satyam’s auditors, PricewaterhouseCooper, is maintaining a stoic silence in the face of widespread public demands for an explanation of how Satyam was allowed to create $1.30 billion in “fictitious” cash on its balance sheet. But, in these recessionary conditions, it is not difficult to figure out how and why financial statements can be manipulated. “Raju was trying to catch the tiger with bare hands,” a Far East agent of Satyam said shortly after the news of the scandal broke. “He was hoping that positive changes in the business environment will convert artificial cash into real cash.”

For those unfamiliar with the intricacies of accounting, this is how the fictitious-cash exercise works: keep asset valuations at inflated levels, be creative in cash-flow (and earnings) recognition methodologies, diminish the true extent of doubtful loans and receivables, and stretch payables out as far as possible. Reads like an extract from an internal memo issued by one of Wall Street’s bailout candidates?

In the wake of the Satyam story, a Franklin Templeton Investments spokesman said that “Satyam is only a short-term negative which, with more regulatory oversight, could turn out into a long-term positive.” The head of Indian equities at Hong Kong-based Mirae Asset Global Investment, Rahul Chadha, reiterated that India remained attractive “primarily on account of quality of management and robust business model.”

But before investors buy into such positivity, they need to be aware of two relevant facts. Firstly, given that the Indian economy is in a phase of extended contraction, it a challenge to find any robust business model at all. Secondly, besides Satyam, there are hundreds of listed Indian companies who are walking that fine line between fictitious cash and hard cash.

Furthermore, Mr. Raju’s deliberate balance-sheet structuring is not fancy-footwork restricted to India. Any number of public companies in Brazil, China, Russia, Turkey, Argentina and Indonesia (to cite a few key examples) are currently facing a similar “fictitious-against-real cash” dilemma. “You have to paint a rosy picture now, if only to keep creditors at bay,” a Mumbai stock broker helpfully suggested yesterday. Without doubt, as the global business climate deteriorates further through 2009, one can reasonably expect many more Satyams to surface.

So there is no need to be shocked by Satyam. Because as long as auditors fail to conduct extensive and precise reconciliations between cash-flow items within financial statements on one hand and contractual obligations which generate those items on the other, innovative managements will always find ways to create an aura of viability. While this is not the appropriate forum to detail other emerging market corporations whose balance sheets are highly suspect, Satyam serves only to reiterate this writer’s short call on emerging markets through exchange-traded funds (ADRE, BKF, EEM, EWX, FRN, PXR), despite the massive 2008 declines.

During an interview with Bloomberg on Thursday, Marshall Mays, director of Emerging Alpha Asset Management, bluntly declared that “all companies lie on earnings.” That is probably the truth, a business reality. The question is, “By how much?”

Well, the more depressing the underlying economic environment, the more is the incentive to lie, fudge, exaggerate and mislead; particularly when, like the rating agencies, even giant auditing firms are unable to perform the most basic of time-honoured due diligence tests. Despite what Indian cabinet ministers are saying, the Satyam problem is not one of lack of regulation. And, before advocating more regulation, lawmakers everywhere (including Washington) are well-advised to put in place credible mechanisms to ensure that auditors and lawyers in the money centres of the world don’t simply sign off on corporate documents, collect hefty fees and then leave investors to find their own way through the maze of dubious financial data.

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